Best Practices for 401(k) Fiduciaries

1. Best Practices for 401(k) Fiduciaries Presented by: Brian M. Pinheiro May 6, 2008

2. Best Practices for 401(k) Fiduciaries • Fiduciary Duty 101 • Am I a fiduciary? • As a fiduciary, what do I have to do? • What do you mean I’m personally liable???????? • Can I delegate my fiduciary responsibility? • Can I protect myself through insurance or otherwise?

3. Am I a Fiduciary? • Named Fiduciaries • Plan Trustee • Plan Administrator • Other Named Fiduciaries

4. Am I a Fiduciary? • Functional Fiduciaries - Anyone who: • Exercises discretionary authority or control over plan management • Exercises any authority or control over plan assets • Renders investment advice for a fee or has other authority or responsibility to do so • Has any discretionary authority or responsibility over plan administration

5. Business Decisions Fiduciary Decisions Am I a Fiduciary?

6. Am I a Fiduciary? • Limits of Fiduciary Status • Performance of purely ministerial tasks is not a fiduciary function • Calculating benefits • Processing claims • Issuing benefit checks • Preparing employee communication material • Maintaining employee service records • Professional service providers (lawyers, actuaries) generally not fiduciaries

7. As a Fiduciary, What Do I Have to Do? • Duty of Loyalty • “Solely in the interest” of Plan participants and beneficiaries • Exclusive purpose rule • Duty of Care • Prudent expert standard • Diversification Rule • Duty of Act in Accordance with Plan Documents

8. As a Fiduciary, What Do I Have to Do? • Duty of Loyalty • Fiduciary must discharge his or her duties solely in the interest of Plan participants and beneficiaries; and • For the exclusive purpose of providing benefits and defraying reasonable plan administrative expenses

9. As a Fiduciary, What Do I Have to Do? • Duty of Loyalty • Cannot lie or intentionally mislead participants • Must accurately convey material information to participants, even if not required to do so. • Cannot act in a way that is intended to benefit a third party to the detriment of plan participants

10. As a Fiduciary, What Do I Have to Do? • Duty of Loyalty • Plan assets can be used to pay reasonable plan administrative expenses • Charge participant accounts • Use the Plan’s forfeiture account • Fiduciary decision • Must be permitted in plan document

11. As a Fiduciary, What Do I Have to Do? • Duty of Loyalty • Expenses must relate to Plan administration • Nondiscrimination testing • Form 5500 preparation • Investment-related fees • Certain legal and professional expenses • Must be reasonable in light of the services provided

12. As a Fiduciary, What Do I Have to Do? • Duty of Care • Fiduciary must discharge his or her duties with the care, skill, prudence and diligence that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of a like character and with like aims • Must diversify Plan investments to minimize risk of large losses unless clearly prudent not to do so

13. As a Fiduciary, What Do I Have to Do? • Duty of Care • Prudent expert standard • If you lack expertise, you have an obligation to seek expert advice • Prudence is a procedural standard • No crystal ball requirement • Must be able to show investigation, deliberation and rational decision making

14. As a Fiduciary, What Do I Have to Do? • Duty of Care • No bright line rule for diversification • Consider: • Purpose of the plan • Economic conditions • Types of investments (stocks, bonds, etc.) • Geographic and industry dispersion • Special exceptions for employer stock, employer real property

15. As a Fiduciary, What Do I Have to Do? • Duty of Act in Accordance with Plan Documents • Fiduciary must discharge his or her duties in accordance with Plan documents, insofar as such documents are consistent with ERISA

16. As a Fiduciary, What Do I Have to Do? • Duty of Act in Accordance with Plan Documents • Could amend Plan to specify available investment options • Does this eliminate fiduciary responsibility for selecting investment options? • May blur the line between business decisions and fiduciary decisions • May give fiduciaries a false sense of security

17. What Do You Mean I Am Personally Liable? • Bad News: Fiduciaries are personally liable • Good News: Only equitable remedies are available • Restitution to the Plan for breach-related losses • Disgorgement of profits obtained by the fiduciary • Other appropriate equitable relief • No punitive damages, pain and suffering, extra-contractual damages

18. What Do You Mean I Am Personally Liable? • Breach of fiduciary duty lawsuit may be initiated by: • U.S. Department of Labor • Plan participant or beneficiary • Another Plan fiduciary • Six-year statute of limitations on fiduciary breach claims

19. What Do You Mean I Am Personally Liable? • Remedy for breach of fiduciary duty must restore the Plan, not individual participants • Recent U.S. Supreme Court case (LaRue) clarifies that a breach affecting a single participant’s 401(k) account is recoverable

20. What Do You Mean I Am Personally Liable? • Civil Penalties • 20% civil penalty imposed by DOL for amount recovered in breach of fiduciary duty lawsuit or settlement • Criminal Penalties • Willful violation may lead to $100,000 in fines ($500,000 for an entity) and 10 years in prison

21. Can I Delegate My Fiduciary Responsibility? • Fiduciaries may delegate their fiduciary duties • Plan document must contemplate delegation • Delegating fiduciary retains fiduciary obligation to monitor performance of delegate

22. Can I Delegate My Fiduciary Responsibility? • Fiduciary duty to manage plan investment starts with the Plan’s trustee • If the trustee is a “directed trustee,” the plan/trust documents identify another “named fiduciary” to make investment decisions • Directed trustee simply carries out investment instructions given by another party

23. Can I Delegate My Fiduciary Responsibility? • Trustee or named fiduciary may delegate investment responsibilities to plan participants • ERISA Section 404(c) allows these fiduciaries to insulate themselves from liability for poor participant investment decisions • BUT, trustee or named fiduciary retains fiduciary responsibility for selecting investment options made available to participants

24. Can I Delegate My Fiduciary Responsibility? • Section 404(c) Limited Protection • Plan must provide a broad range of investment alternatives • Must have at least three diversified investment alternatives • Give each participant a reasonable opportunity to materially affect risk and return in his account • Minimize the risk of large losses

25. Can I Delegate My Fiduciary Responsibility? • Section 404(c) Limited Protection • Participants must have reasonable opportunity to provide investment instructions that must be followed • Permit investment instructions at least quarterly • Most plans allow daily instructions • May have reasonable restrictions (e.g., day trading) • Applies to voting, tender and similar rights

26. Can I Delegate My Fiduciary Responsibility? • Section 404(c) Limited Protection • Must provide required information • Explanation that plan is intended to satisfy 404(c) and that fiduciaries may be relieved of liability for losses • Description of investment alternatives • Investment objectives • Risk and return characteristics • Diversification of underlying assets

27. Can I Delegate My Fiduciary Responsibility? • Section 404(c) Limited Protection • Must provide required information, cont. • Description of procedure for giving instructions • Description of fees and expenses • Description of limitations on investment changes • Fiduciary contact information • Copy of most recent prospectus following participant’s initial investment in an option • Description of voting and tender rights

28. Can I Delegate My Fiduciary Responsibility? • Section 404(c) Limited Protection • Must provide certain information upon request • Annual operating expenses of each investment alternative • Copies of prospectuses, financial reports, etc. • List of assets comprising the portfolio of any investment options • Past and current investment performance

29. Can I Protect Myself Through Insurance or Otherwise? • Employer may indemnify fiduciaries for any losses • Incoming fiduciaries should check the employer’s organization documents and bylaws • Bad faith claims often not covered • Plan may NOT indemnify the fiduciaries

30. Can I Protect Myself Through Insurance or Otherwise? • Fiduciary insurance is available to protect fiduciaries from liability • Plan also may purchase fiduciary insurance to protect itself against breaches of fiduciary duty • Plan may NOT purchase insurance to protect the fiduciaries

31. 401(k) and 403(b) Fees • Impact of Fees • Over $2 trillion invested in 401(k) plans • Closer to $3 trillion after adding 403(b) and governmental 457(b) plans • Opportunities to earn significant fees

32. 401(k) and 403(b) Fees • Types of Fees • Investment-related fees • 80-90% of all fees • Expense ratios • 12b-1 fees • Shareholder services • Front-end and back-end loads • Redemption fees

33. 401(k) and 403(b) Fees • Types of Fees • Recordkeeping fees • Set-up and maintenance of 401(k) plan • Enrollment • Processing participant elections • Preparing and mailing account statements • Check-cutting and plan loan fees • Trustee fees • Legal and professional fees

34. 401(k) and 403(b) Fees • Types of Fees • Insurance and other fees • Insurance wrapper fees • Lost investment earnings on GICs • Surrender fees

35. 401(k) and 403(b) Fees • How are Fees Expressed? • Hard Dollar Fees • Flat rate per participant per month • Total fees do not change automatically with changes in plan assets

36. 401(k) and 403(b) Fees • How are Fees Expressed? • Revenue Sharing Arrangements • Mutual funds, common or collective trusts, and insurance GICs share fees with 401(k) service providers • Results in higher expense ratios • Lower rates of investment return • Higher fees as plan assets grow

37. 401(k) and 403(b) Fees • Fee Litigation: Hecker v. Deere & Company • Deere offers 2 plans administered and trusteed by Fidelity • $2.5 billion in assets • 26 funds (23 are Fidelity funds) • 2,500 funds available through brokerage option • Fees range from .07% to 1.01%

38. 401(k) and 403(b) Fees • Plaintiffs allege that Deere and Fidelity breached their ERISA fiduciary duties • Plans paying excessive and unreasonable fees for the investment options • Fiduciaries failed to disclose all information on fees and costs • No disclosure of the revenue sharing arrangements between Fidelity as investment manager and Fidelity as plan trustee

39. 401(k) and 403(b) Fees • According to plaintiffs: • Deere did not understand the fee structures in the investment options • Deere failed to implement a process to ensure the reasonableness of fees • Deere failed to negotiate over fees

40. 401(k) and 403(b) Fees • District Court ruled in favor of Deere and Fidelity • ERISA 404(c) protects the fiduciaries • Some of the 2,500 funds must not have excessive fees, and it is up to participants to choose wisely • No statutory or regulatory duty to disclose detail on fee arrangements • Not clear that anything beyond the total amount of fees would affect participant investment decisions

41. 401(k) and 403(b) Fees • DOL Appellate Brief • ERISA 404(c) is not a fiduciary defense for excessive fees • If the breach relates to fees, it is attributable to the fiduciary’s selection of the fund as an option, not to the participant’s investment decision • Suggests that fiduciaries could be liable for not negotiating fees down

42. 401(k) and 403(b) Fees • DOL Appellate Brief • Fiduciaries may be liable for making misleading or incomplete disclosure about fees, even if disclosure not required • DOL is “skeptical” that disclosure of all detail on revenue sharing arrangements is required

43. 401(k) and 403(b) Fees • DOL Proposed Regulation • Service provider contracts must ensure disclosure of fee and conflicts information • Requires disclosure of: • ALL compensation to be received by service provider • ANY potential conflicts of interest • Applies to virtually all parties who may receive fees in connection with a 401(k) plan

44. Best Practices • Fiduciary Best Practices • Identify and train 401(k) plan fiduciaries • Who is responsible for choosing investments • What are their fiduciary duties and responsibilities • Consider independent investment expert • Develop an investment policy statement • Guidelines for selecting investment options • Establishes performance benchmarks

45. Best Practices • Fiduciary Best Practices • Review all service provider arrangements • Identify revenue sharing arrangements • Segregate investment fees from recordkeeping fees • Reduce all service provider relationships to writing • Update disclosures to plan participants